PBOC remains hands off as China’s bond yields hit record low

China's 10-year government bond yield has plummeted to an all-time low of 2.17%, signaling growing concerns about the world's second-largest economy.

This record low undercuts the previous bottom of 2.18% set on July 1 as the People's Bank of China (PBOC) attempts to revive a sputtering economy by cutting interest rates.

This strategy has backfired, pushing bond yields even lower. That indicates that investors aren’t feeling optimistic about China’s economic prospects.

The PBOC is now walking a tightrope, trying to juice the economy without sending the financial markets into a tailspin.

"The PBOC would want to warn market again, but not necessary start selling bonds right away," said Becky Liu, head of China macro strategy at Standard Chartered Bank. "PBOC is not targeting a hard line, it is targeting the shape of the curve."

What Liu is saying here is that the central bank is more focused on the big picture—the overall pattern of interest rates for different loan lengths—rather than defending a specific yield level. This broader strategy aims to keep the economy humming by influencing borrowing and investment across different time frames.

It’s a risky move.

How low can bond yields go?

Extremely low bond yields can threaten financial stability by encouraging excessive risk-taking and creating asset bubbles. Low yields could also lead to capital outflows and a weakening of the yuan.

However, China isn’t likely going to hit the brakes just yet.

"There is no doubt that China needs lower rates for growth, and the market will likely continue to rationally expect this," said Gary Ng, an economist at Natixis SA in Hong Kong earlier this month. "It is possible that the PBOC may intervene suddenly and try to manage yields at a range, but it will not fully deter the market force."

A Bloomberg survey had suggested 2.25% was a red line for the PBOC for the benchmark 10-year note.

However, Liu told Bloomberg otherwise earlier this month.

“People had thought 2.5% was the hard line for the 30-year CGB yield,” Liu said. “Now the new comfort level could as well be at 2.4%.”

Meanwhile, Goldman Sachs Group Inc. economists led by Xinquan Chen forecast the 10-year yield to be 2.1% by the end of the year.

‘The chance has increased’ that PBOC will intervene

To address falling yields, the PBOC is prepared to intervene in the bond market if need be. It has announced it has a large amount of medium- and long-term bonds available, which it can use to influence market supply and potentially push yields higher.

However, the timing of any intervention remains uncertain.

"The chance has increased," said Albert Leung, a rates strategist at Nomura Holdings Inc. "But it's hard to call the timing as this week's rate cut probably shows lower overall social financing cost is a higher priority than drawing a line in the sand in how long CGB yields can go."